Nobody Cares About The Fixed Costs Of Your Book, Movie, Whatever

from the this-is-economics dept

We recently pointed out that book publishers are fooling themselves by thinking that they must charge super high prices on ebooks. That post seemed to set off some angry folks inside the publishing industry who did the standard thing: talking about all of the overhead that goes into publishing a book. We hear this all the time. But it's meaningless. It's cost-based accounting, rather than value-based accounting.

The consumer doesn't care how much it cost you to make the original.

Nor should they. They only care about the value to them of the single copy they get. And this makes sense for a variety of reasons, both economically and psychologically. This is the point that economists have been making for ages, trying to get people to understand the difference between fixed costs and marginal costs. Fixed costs don't impact pricing. Maginal costs (the cost to produce the copy) do. That's not to say that the fixed costs aren't important -- they are -- but they don't factor into the pricing decision, they factor into the investment decision. That is, you don't take on a project if you don't think you can create a business model that will give a total return on investment over the fixed and marginal costs. But the pricing on the individual item is entirely about the marginal costs. And this is actually a good thing. If you did pricing based on the average cost, including fixed costs, you actually lose the incentive to be more efficient and lower your fixed costs, since you get to just bake them into the price. But the public doesn't care about how much you spent. As far as they're concerned, you may have spent stupidly and inefficiently. They only care about the marginal benefit they get from the copy.

In many ways this is reminiscent of the stupid debate we've had for years, where a lobbyist from NBC Universal kept challenging me to explain how he could keep making $200 million movies. But that's stupid. If you start from the assumption of a high cost, you're not building value, you're just spending budget. All we should care about is how people can make profitable offerings, and there are lots of ways to do that at a variety of price points -- but you should never set the pricing decisions on the fixed costs, because the buyer simply doesn't care.

An e-book is a digital good. Ephemeral and intangible. Sometimes we don’t even have access to the e-book itself in the form of a file — in the case of Amazon, we’re just “renting” the e-book the same way you rent Taco Bell food. You bought it. It’s inside your device. But if Amazon decides you don’t need it anymore, one snap of the wizard’s fingers and the e-books are poof, gone, siphoned from your reader like gas from a gas-tank. E-books have no supply — if I buy one, it doesn’t reduce how many remain, because theoretically infinite copies remain. No cost to reprint. No cost to remake. It just… sits out there, attempting to be the very embodiment of the Long Tail.

This is what the audience sees and believes.

It matters little what the e-book actually costs.

It only matters what the audience thinks they should cost.

Your costs don't determine the price. The market determines the price, and ignoring what the market thinks is a big mistake.

And, of course, this applies to all sorts of content. As I was writing this, I came across a similar discussion, but on the movie side of things. It's a post by Stacey Parks at the Independent Filmblog, which notes that nobody cares what you spent on your film. She's not talking about end consumers per se (though it applies to them as well), but distributors who buy films. And this actually drives home the overall point: in a functioning market, no buyer -- whether a middleman/wholesaler or an end user -- cares one bit what the total cost of production was. They only care about the marginal benefit to them in relation to the supply. This is just classic economics -- and those who seek to price it outside of what economics suggests is reasonable will discover that people just don't pay. It's not because they don't understand how much money you put into fixed costs. It's because you spending so much on fixed costs is your problem, not the buyer's.